How can aspiring entrepreneurs—and the investors and associates who join the venture—get the odds of success on their side? What do these talented and successful high-potential entrepreneurs, their ven- ture capitalists, and their private backers do differ- ently? What is accounting for their exceptional record? Are there general lessons and principles un- derlying their successes that can benefit aspiring en- trepreneurs, investors, and those who would join a venture? If so, can these lessons be learned?
These are the central questions of our lifetime work. We have been immersed as students, research- ers, teachers, and practitioners of the entrepreneurial
process. As founding shareholders and investors of
several high-potential ventures (some of which are now public), directors and advisors to ventures and venture capital funds, a charter director and advisor to the Kauffman Center for Entrepreneurial Leader- ship at the Ewing Marion Kauffman Foundation, and as director of the Arthur M. Blank Center for Entre- preneurship at Babson College, we have each ap- plied, tested, refined, and tempered academic theory as fire tempers iron into steel: in the fire of practice.
Intellectual and Practical Collisions with the Real World
Throughout this period of evolution and revolution, New Venture Creation has adhered to one core prin- ciple: In every quest for greater knowledge of the entrepreneurial process and more effective learning, there must be intellectual and practical collisions be- tween academic theory and the real world of prac- tice. The standard academic notion of something being all right in practice but not in theory is unac- ceptable. This integrated, holistic balance is at the heart of what we know about the entrepreneurial process and getting the odds in your favor.
Value Creation: The Driving Forces
A core, fundamental entrepreneurial process accounts for the substantially greater success pattern among higher-potential ventures. Despite the great variety of
businesses, entrepreneurs, geographies, and technol- ogies, central themes or driving forces dominate this highly dynamic entrepreneurial process.
It is opportunity driven.
It is driven by a lead entrepreneur and an entrepreneurial team.
It is resource parsimonious and creative. It depends on the fit and balance among these. It is integrated and holistic.
It is sustainable .
These are the controllable components of the en- trepreneurial process that can be assessed, influ- enced, and altered. Founders and investors focus on these forces during their careful due diligence to ana- lyze the risks and determine what changes can be made to improve a venture’s chances of success. First, we will elaborate on each of these forces to provide a blueprint and a definition of what each means. Then using Google as an example, we will il- lustrate how the holistic, balance, and fit concepts pertain to a start-up.
Change the Odds: Fix It, Shape It, Mold It, Make It
The driving forces underlying successful new venture creation are illustrated in Exhibit 3.5. The process starts with opportunity, not money, strategy, net- works, team, or the business plan. Most genuine op- portunities are much bigger than either the talent and capacity of the team or the initial resources avail- able to the team. The role of the lead entrepreneur and the team is to juggle all these key elements in a changing environment. Think of a juggler bouncing up and down on a trampoline that is moving on a conveyor belt at unpredictable speeds and directions, while trying to keep all three balls in the air. That is the dynamic nature of an early-stage start-up. The business plan provides the language and code for communicating the quality of the three driving forces of the Timmons Model and of their fit and balance. In the entrepreneurial process depicted in the Timmons Model, the shape, size, and depth of the op- portunity establish the required shape, size, and depth of both the resources and the team. We have found that many people are a bit uncomfortable viewing the opportunity and resources somewhat precariously balanced by the team. It is especially disconcerting to some because we show the three key elements of the entrepreneurial process as circles, and thus the bal- ance appears tenuous. These reactions are justified, accurate, and realistic. The entrepreneurial process is dynamic. Those who recognize the risks better man- age the process and garner more return.
Copyright © The McGraw-Hill Companies, Inc.
96 Part II The Opportunity
The lead entrepreneur’s job is simple enough. He or she must carry the deal by taking charge of the suc-
cess equation. In this dynamic context, ambiguity and
risk are actually your friends. Central to the home- work, creative problem solving and strategizing, and due diligence that lie ahead is analyzing the fits and gaps that exist in the venture. What is wrong with this opportunity? What is missing? What good news and favorable events can happen, as well as the adverse? What has to happen to make it attractive and a fit for me? What market, technology, competitive, manage- ment, and financial risks can be reduced or elimi- nated? What can be changed to make this happen? Who can change it? What are the least resources nec- essary to grow the business the farthest? Is this the right team? By implication, if you can determine these answers and make the necessary changes by figuring out how to fill the gaps and improve the fit and attract key players who can add such value, then the odds for success rise significantly. In essence, the entrepre- neur’s role is to manage and redefine the risk–reward equation—all with an eye toward sustainability. Be- cause part of the entrepreneur’s legacy is to create positive impact without harming the environment, the community, or society, the concept of sustainability appears as the underlying foundation in the model.
The Opportunity At the heart of the process is
the opportunity. Successful entrepreneurs and in- vestors know that a good idea is not necessarily a
good opportunity. For every 100 ideas presented to investors in the form of a business plan or proposal, usually fewer than 4 get funded. More than 80 per- cent of those rejections occur in the first few hours; another 10 to 15 percent are rejected after investors have read the business plan carefully. Fewer than 10 percent attract enough interest to merit a more due diligence thorough review that can take several weeks or months. These are very slim odds. Count- less hours and days have been wasted by would-be entrepreneurs chasing ideas that are going nowhere. An important skill for an entrepreneur or an investor is to be able to quickly evaluate whether serious po- tential exists, and to decide how much time and ef- fort to invest.
John Doerr is a senior partner at one of the most famous and successful venture capital funds ever, Kleiner , Perkins, Caulfield & Byers , and is considered by some to be the most influential venture capitalist of his generation. During his career, he has been the epitome of the revolutionaries described earlier, who have created new industries as lead investors in such legends as Sun Microsystems, Compaq Computer, Lotus Development Corporation, Intuit, Genentech , Millennium, Netscape, and Amazon.com. Regardless of these past home runs, Doerr insists, “There’s never been a better time than now to start a company. In the past, entrepreneurs started businesses. Today they in- vent new business models. That’s a big difference, and it creates huge opportunities.” 31
Business plan Communication
Fits and gaps
Ambiguity Exogenous forces
Leadership Creativity
Uncertainty Capital market context
Opportunity Resources
Team
Founder
Sustainability: For environment, community, and society EXHIBIT 3.5
The Timmons Model of the Entrepreneurial Process
Copyright © The McGraw-Hill Companies, Inc.
Another venture capitalist recently stated, “Cycles of irrational exuberance are not new in venture in- vesting. The Internet bubble burst, we came back to earth, and then we began another period of excessive valuation that is subsiding in late 2007 with a credit squeeze. ” 32
Exhibit 3.6 summarizes the most important char- acteristics of good opportunities. Underlying market demand—because of the value-added properties of the product or service, the market’s size and 20-plus percent growth potential, the economics of the business, particularly robust margins (40 percent or more), and free cash flow characteristics—drives the value creation potential.
We build our understanding of opportunity by first focusing on market readiness: the consumer trends and behaviors that seek new products or services. Once these emerging patterns are identified, the as- piring entrepreneur develops a service or product concept, and finally the service or product delivery system is conceived. We then ask the questions ar- ticulated in the exhibit.
These criteria will be described in great detail in Chapter 5 and can be applied to the search and evalu-
ation of any opportunity. In short, the greater the growth, size, durability, and robustness of the gross and net margins and free cash flow, the greater the opportunity. The more imperfect the market, the greater the opportunity. The greater the rate of change, the discontinuities, and the chaos, the greater is the opportunity. The greater the inconsistencies in existing service and quality, in lead times and lag times, and the greater the vacuums and gaps in infor- mation and knowledge, the greater is the opportunity.
Resources: Creative and Parsimonious One of the most common misconceptions among un- tried entrepreneurs is that you first need to have all the resources in place, especially the money, to suc- ceed with a venture. Thinking money first is a big mistake. Money follows high-potential opportunities conceived of and led by a strong management team. Investors have bemoaned for years that there is too much money chasing too few deals. In other words, there is a shortage of quality entrepreneurs and op- portunities, not money. Successful entrepreneurs de- vise ingeniously creative and stingy strategies to marshal and gain control of resources ( Exhibit 3.7 ). Surprising as it may sound, investors and successful entrepreneurs often say one of the worst things that can happen to an entrepreneur is to have too much
money too early.
Howard Head is a wonderful, classic example of succeeding with few resources. He developed the first metal ski, which became the market leader, and then the oversize Prince tennis racket; developing two totally unrelated technologies is a rare feat. Head left his job at a large aircraft manufacturer during
32 Ernie Parizeau , Partner, Norwest Venture Partners, June 2007. EXHIBIT 3.6
The Entrepreneurial Process Is Opportunity Driven*
Market demand is a key ingredient to measuring an opportunity: • Is customer payback less than one year?
• Do market share and growth potential equal 20 percent annual growth and is it durable?
• Is the customer reachable?
Market structure and size help define an opportunity: • Emerging and/or fragmented?
• $50 million or more, with a $1 billion potential? • Proprietary barriers to entry?
Margin analysis helps differentiate an opportunity from an idea: • Low-cost provider (40 percent gross margin)? • Low capital requirement versus the competition? • Break even in 1– 2 years?
• Value added increase of overall corporate P/E ratio?
Opportunity
Market segments
*Durability of an opportunity is a widely misunderstood concept. In entrepreneurship, durability exists when the investor gets her money back plus a market or better return on investment.
EXHIBIT 3.7
Understand and Marshall Resources, Don’t Be Driven by Them
Minimize and control
versus
Maximize and own
Resources
Unleashing creativity Financial resources
Assets People
Your business plan
Think cash last!
Bootstrapping
Copyright © The McGraw-Hill Companies, Inc.
98 Part II The Opportunity
World War II and worked in his garage on a shoe- string budget to create his metal ski. It took more than 40 versions before he developed a ski that worked and could be marketed. He insisted that one of the biggest reasons he finally succeeded is that he had so little money. He argued that if he had com- plete financing he would have blown it all long before he evolved the workable metal ski.
Bootstrapping is a way of life in entrepreneurial companies and can create a significant competitive advantage. Doing more with less is a powerful com- petitive weapon. Effective new ventures strive to minimize and control the resources, but not neces- sarily own them. Whether it is assets for the business, key people, the business plan, or start-up and growth capital, successful entrepreneurs think cash last. Such strategies encourage a discipline of leanness, where everyone knows that every dollar counts, and the principle “conserve your equity” (CYE) becomes a way of maximizing shareholder value.
The Entrepreneurial Team There is little dis-
pute today that the entrepreneurial team is a key in- gredient in the higher-potential venture. Investors are captivated “by the creative brilliance of a compa- ny’s head entrepreneur: a Mitch Kapor , a Steve Jobs, a Fred Smith . . . and bet on the superb track records of the management team working as a group.” 33 Ven-
ture capitalist John Doerr reaffirms General George Doriot’s dictum: I prefer a Grade A entrepreneur and team with a Grade B idea, over a Grade B team with a Grade A idea. Doerr stated, “In the world today, there’s plenty of technology, plenty of entrepreneurs, plenty of money, plenty of venture capital. What’s in short supply is great teams. Your biggest challenge will be building a great team.” 34
Famous investor Arthur Rock articulated the im- portance of the team more than a decade ago. He put it this way: “If you can find good people, they can al- ways change the product. Nearly every mistake I’ve made has been I picked the wrong people, not the wrong idea.” 35 Finally, as we saw earlier, the ventures
with more than 20 employees and $2 million to $3 million in sales were much more likely to survive and prosper than smaller ventures. In the vast majority of cases, it is very difficult to grow beyond this with- out a team of two or more key contributors.
Clearly a new venture requires a lead entrepre- neur that has personal characteristics described in Exhibit 3.8 . But the high-potential venture also re- quires interpersonal skills to foster communications and, therefore, team building.
Exhibit 3.8 summarizes the important aspects of the team. These teams invariably are formed and led by a very capable entrepreneurial leader whose track record exhibits both accomplishments and several qualities that the team must possess. A pacesetter and culture creator, the lead entrepreneur is central to the team as both a player and a coach. The ability and skill in attracting other key management mem- bers and then building the team is one of the most valued capabilities investors look for. The founder who becomes the leader does so by building heroes in the team. A leader adopts a philosophy that re- wards success and supports honest failure, shares the wealth with those who help create it, and sets high standards for both performance and conduct. We will examine in detail the entrepreneurial leader and the new venture team in Chapter 8.
Importance of Fit and Balance Rounding
out the model of the three driving forces is the con- cept of fit and balance between and among these forces. Note that the team is positioned at the bottom of the triangle in the Timmons Model (Exhibit 3.5). Imagine the founder, the entrepreneurial leader of the venture, standing on a large ball, balancing the triangle over her head. This imagery is helpful in ap- preciating the constant balancing act because oppor- tunity, team, and resources rarely match. When envisioning a company’s future, the entrepreneur can
33 W . D. Bygrave and J. A. Timmons , Venture Capital at the Crossroads (Boston: Harvard Business School Press, 1992), p. 8.
34 Fast Company, February–March 1997, p. 84.
35 A. Rock, “Strategy vs. Tactics from a Venture Capitalist,” Harvard Business Review, November–December 1987, pp. 63–67. EXHIBIT 3.8
An Entrepreneurial Team Is a Critical Ingredient for Success
Team An entrepreneurial leader
• Learns and teaches—faster, better • Deals with adversity, is resilient • Exhibits integrity, dependability, honesty • Builds entrepreneurial culture and organization
Quality of the team
• Relevant experience and track record • Motivation to excel
• Commitment, determination, and persistence • Tolerance of risk, ambiguity, and uncertainty • Creativity
• Team locus of control • Adaptability
• Opportunity obsession • Leadership and courage • Communication
Copyright © The McGraw-Hill Companies, Inc.
ask, What pitfalls will I encounter to get to the next boundary of success? Will my current team be large enough, or will we be in over our heads if the company grows 30 percent over the next two years? Are my re- sources sufficient (or too abundant)? Vivid examples of the failure to maintain a balance are everywhere, such as when large companies throw too many re- sources at a weak, poorly defined opportunity. For ex- ample, Lucent Technologies’ misplaced assumption of slowness to react to bandwidth demand resulted in an almost 90 percent reduction in market capitalization.
Sustainability as a Base Building a sustain-
able venture means achieving economic, environ- mental, and social goals without compromising the same opportunity for future generations. The sea change in entrepreneurship regarding environment, community, and society is driven by many factors. We are seeing an elevated social awareness concerning a wide range of sustainability-related issues, including human rights, food quality, energy resources, pollu- tion, global warming, and the like. By understanding these factors, the entrepreneur builds a firmer base, girding the venture for the long term.
While the drawings oversimplify these incredibly complex events, they help us to think conceptually— an important entrepreneurial talent—about the company-building process, including the strategic and management implications of striving to achieve balance, and the inevitable fragility of the process. Visually, the process can be appreciated as a constant
balancing act, requiring continual assessment, re- vised strategies and tactics, and an experimental approach. By addressing the types of questions nec- essary to shape the opportunity, the resources, and the team, the founder begins to mold the idea into an opportunity, and the opportunity into a business, just as you would mold clay from a shapeless form into a piece of art.
Exhibit 3.9a–c shows how this balancing act evolved for Google from inception through its initial public and secondary offerings. Back in 1996, online search was a huge, rapidly growing, but elusive op- portunity. There were plenty of early entrants in the search space, but none had yet broken out of the pack. Stanford graduate students Larry Page and Sergey Brin began to collaborate on a search engine called BackRub , named for its unique ability to ana- lyze the “back links” pointing to a given website . Within a year, their unique approach to link analysis was earning their dorm-room search engine a grow- ing reputation as word spread around campus. Still, they had no team and no capital, and their server ar- chitecture was running on computers they borrowed from their computer science department.
Such a mismatch of ideas, resources, and talent could quickly topple out of the founders’ control and